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China's factory sector turned in its best performance in five months in May, a preliminary HSBC survey showed on Thursday, though overall manufacturing growth still contracted slightly in a suggestion that the outlook remains murky.

The HSBC Flash China Manufacturing Purchasing Managers' Index (PMI) recovered to 49.7 in May from April's final reading of 48.1, beating a Reuters' poll forecast of 48.1.

But the data is a touch below the 50-point level that separates a monthly growth in activity from a contraction, indicating that manufacturers actually experienced a slight drop in business.

Still, those hoping for any sign of stabilisation in China's wobbly economy may find some welcome relief in Thursday's report.

Asian stocks and emerging Asian currencies extended early gains after the report, while the Australian dollar edged higher.

A breakdown of the survey results showed the handful of closely-followed indices that measure output, domestic and foreign demand all improved substantially in May to rise above the 50-point mark, from sub-50 levels in April.

New export orders, a proxy for foreign demand, showed the biggest turnaround. The index climbed a hefty 3.4 points to 52.7, a level not seen in nearly 3-1/2-years.

"The improvement was broad-based with both new orders and new export orders back in expansionary territory. Disinflationary pressures also eased over the month and output prices increased for the first time since November 2013," said Qu Hongbin, chief economist for China at HSBC.

"Some tentative signs of stabilisation are emerging, partly as a result of the recent mini-stimulus measures and lower borrowing costs. But downside risks to growth remain, particularly as the property market continues to cool. We think more policy easing is needed to put a floor under growth in the coming months."

He also noted the employment index fell further to 47.3, which implies that this month's uptick in sentiment has not yet filtered through to the labour market.

Of the 11 sub-indices in the survey, all but those for employment and stocks of finished goods rose compared to April.

In the case of employment, the index fell over a point to stand well under 50, the 13th consecutive month that jobs have been lost in the manufacturing sector.

Any marked weakening in the labour market would raise alarm bells for China's government, which regards healthy employment levels as a top policy priority and an important condition for social stability.

Premier Li Keqiang said in March that it is all right if economic growth comes in slightly